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Automatic wealth The 6 steps to financial independence - Masreson M.

Masreson M. Automatic wealth The 6 steps to financial independence - Wiley & sons , 2005. - 291 p.
ISBN 0-471-71027
Download (direct link): automaticwealththesixstepsto2005.pdf
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My actual net rents over the four years were $7,934 minus $1,500 (one month of rent in year one) minus $1,654 (one month of rent in year three). So my net rents for the four years were $4,780 (an average of about $100 a month).
Step 5: Get Richer While You Sleep 201
If we add this to my profits from appreciation and amortization, we get my total profits:
Total net rents of $4,780
Plus profits from appreciation and amortization of $159,200 Equals total profits of $163,980
So in four yearsí time, I made about $164,000 on a property I bought for $182,000. But that doesnít mean I almost doubled my money. I made much more than that because of leverage.
I didnít pull $182,000 out of my pocket to buy the house. My initial investment was the down payment, renovation costs, and closing costs on the purchase. Those, as weíve seen, totaled $65,400. So my profit, as a percentage of my original investment, was actually 251 percent.
Total profits of $163,980
Divided by total initial investment of $65,400
Equals leveraged profits of 251%
Same House, Very Different Results
I made a significant profit on this house. Yet the woman who bought it from me wasnít nearly as fortunate. She is also an investor. And she had made great money on various properties here in town as the market rocketed up 15 percent to 20 percent in recent years. She bought my house at $390,000, moved in, put $20,000 into it, and then put it on the market for $475,000.
But there were no buyers at that price. Or at $450,000, or
$425,000, or $400,000. After a year on the market, she unloaded it for
$350,000órepresenting roughly a $101,000 loss.
Hereís how her deal looked. First, we calculate the appreciation (or, in this case, the depreciation):
Sale price of $390,000
Less purchase price of $350,000
Equals depreciation of $40,000
Next, we look at her gross equity when she finally sold the house:
202 AUTOMATIC WEALTH
Sales price of $350,000
Less loan balance due at sale of $308,600*
Equals gross equity of $41,400
Then, we take out sales commission and closing costs to get her net equity:
Gross equity of $41,400
Less 6% sales commission of $23,400
Less sellerís closing costs of $2,000
Equals net equity $16,000
Now, letís figure her total, out-of-pocket expenses:
Down payment of $78,000
Plus closing costs on purchase of $6,000
Plus renovations of $20,000
Equals total initial investment of $104,000
Add to that what she lost from the depreciation:
Net equity of $16,000
Less total initial investment of $104,000
Loss after depreciation and amortization of -$88,000
And now her carrying costs, which were more than mine since she paid more than twice what I did for the house and because taxes and insurance go up with higher sales prices:
Principal and interest of $1,875
Plus taxes of $500
Plus insurance of $150
Plus average monthly maintenance of $150
Equals total monthly carrying costs of $2,675
*Buyer borrowed 80 percent of $390,000, or $312,000. Interest rates had fallen to 6.5 percent by this time. After one year at 6.5 percent, her balance due on the loan, or payoff amount, was $308,600.
Step 5: Get Richer While You Sleep 203
Since we now know what she has to spend to keep the property and since we know what she receives in rent, we can figure her net rents. In this case, the net rents are negative:
Rental income of $1,825
Less monthly carrying costs of $2,675
Equals negative net rent of $850
Yearly negative net rent -$10,200
In addition to this, she had one month of vacancy in the year she
owned the property. So her net rents for the year were -$12,025 ($10,200 - $1,825).
Total negative net rents of -$12,025
Plus loss after depreciation and amortization of -$88,000
Equals total loss of -$100,025
So why did this woman lose so much money when I made so much on the same house?
Autopsy of a Bad Deal
The number one mistake this buyer made was that she didnít have a margin of safety going into the deal. Her purchase price wasnít anchored to reality by rental values. By contrast, when I first bought the house, at $182,000, it had a $1,500 monthly rental value. Since interest rates were 7.5 percent at the time, my rental income covered my loan payments, taxes, insurance, and maintenance and still gave me a 5 percent margin of safety.
Thatís not a huge margin of safety but a fair one, given the strong appreciation potential of the neighborhood. Whatís more, as rents rose, my margin of safety increased every year. By year four, I was receiving rent of around $1,736 a month and netting $253 after all expenses.
That meant rents could fall as much as 15 percent at that point without my experiencing negative cash flow. And if the rise in housing prices suddenly dipped, or even stopped, I could afford to bide my time.
204 AUTOMATIC WEALTH
By contrast, by the time this woman bought the house from me, the rental value had risen to only about $1,825. Even though interest rates had come down to 6.5 percent at that point, the rent still wasnít nearly enough to cover her loan paymentsólet alone her other costs.
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